Now let’s apply these principles to property. With every year that property prices increase, the increase builds upon the increase of the year before. In other words price growth is compound and not linear. I’m sure you know what I’m trying to say but let me explain anyway
According to the Nationwide, average house prices in the UK have increased by a little over 8% per annum since Q4 1952, even with taking into account recessions and periods when house prices were static (and that’s not too many of them!).
Let’s assume for now that house prices continue to grow on trend – we will come back to this point a little later.
Let’s suppose we buy a property for £200,000. What can we expect in the way of growth?
Well, if growth were only linear we can see from this chart that the value at the end of twenty-five years – I’ve taken twenty-five years because it’s a fairly typical mortgage term would be £600,000.
What do I mean by linear? Well, we know the property is worth £200,000 and if it goes up by 8% per annum, so that’s £16,000 a year. So if it goes up £16,000, or 8% of the original purchase price or the original investment each year then, after twenty-five years, it will be worth £600,000.
This is an increase of 300% which some of you may find exciting, but you and I know that when Nationwide or any other statistical service talk about house price growth they are not talking about linear growth – they aren’t referring to a % increase of the value of properties when they started their index.
Instead, they are talking about the increase on last years figure. And that means that each year’s little bit of growth also grows by 8%. In other words growth is compound. I know you know all this but I just want to illustrate what this means for investors.
The cumulative effect is that property prices don’t grow in a straight line like that shown on the chart, they actually grow exponentially. Let me show you what difference that makes.
Now the cumulative effect of all the little bits of each years growth also growing at 8%, as well as the original investment of £200,000, is that at the end of twenty-five years the property is worth £1.37m
That’s an increase of 685%, more than double the growth we had before when we looked at linear growth.
Look at this chart showing the growth compounding at 8% a year.
You can see it’s not straight any more, there’s a very definite curve – with growth accelerating towards the end of the period.
In fact, if you look at the figures the value grows significantly more in the last ten years than during the first ten years. In the first ten years the monetary value of the property grows by £231,785 from £200,000 to £431,785. But in the last ten years the monetary value grows by £684,506, from £685,000 to £1.37m.That’s three times the amount of monetary growth in the last ten years than in the first ten years.
I’m sure the maths is nothing new to you but many investors are amazed when they see the figures mapped out like this.
You might be too and you might be thinking “there must be implications for me as an investor” and, of course, there are. We’ll look at these in the next post.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor